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Tesoro Corporation (NYSE:TSO)

Q3 FY08 Earnings Call

October 30, 2008, 08:30 AM ET

Executives

Scott Phipps - Director of IR

Otto C. Schwethelm - Sr. VP, CFO and Treasurer

Everett Lewis - EVP and COO

Bruce A. Smith - Chairman, President and CEO

Dan Porter - Sr. VP, Refining

Analysts

Jeff Dietert - Simmons & Company International

Chi Chow - Tristone Capital

Paul Sankey - Deutsche Bank

Ann Kohler - Caris & Company

Roger Read - Natixis Bleichroeder

Paul Cheng - Barclays Capital

Arjun Murti - Goldman Sachs

Neil McMahon - Sanford Bernstein

Operator

Good morning, my name is Pamela and I will be your conference operator today. At this time I would like to welcome everyone to the Third Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. [Operator Instructions] Thank you. Mr. Scott Phipps, you may begin your conference.

Scott Phipps - Director of Investor Relations

Thanks, Pamela. Good morning everyone and welcome to today's conference call to discuss our third quarter 2008 earnings. As we progress for this morning's material, management will be referencing slides that were filed with the SEC about 30 minutes ago. I would encourage you to have these available as we progress through this morning's material.

If you don't already have the presentation, you can visit the investors section of the website at www.tsocorp.com in order to download them. On the website, you can also obtain a copy of the earnings release we issued last night or review the company's supplemental quarterly data.

The earnings release contains additional information in the attached tables on our business. In addition, we have updated the other supplemental financial and operational information on our website that is not included in the release. After reviewing this information, please feel free to contact me with any questions about the material or otherwise following today's call. Please refer to the forward-looking statements in the appendix of the earnings slides, which says... which makes statements made during this call that refer to management's expectations and/or future predictions are forward-looking statements intended to be covered by the Safe Harbor provisions of the Securities Act. As there are many factors which could cause results to differ from our expectations. With that said I'll turn the call over to Otto.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Thanks Scott and good morning everyone. In a significant reversal of early year financial performance, the company reported one of its best quarters ever yesterday highlighting our ability to quickly to adapt to the volatile market, execute self help initiatives and generate cash.

Turning to the presentation. On slide 1 you can see in the third quarter, our income was $258 million which is $1.86 a share. Refining operating income was $476 million and almost $400 million improvement versus the prior quarter due to the improved capture rates and lower energy costs in addition to lower impact from derivative positions.

Retail operating income was $34 million as fuel margins averaged $0.30 a gallon during the quarter. Corporate and unallocated expense for the quarter was $58 million versus $47 million during the second quarter of 2008. The $11 million difference was primarily due to our stock-based compensation expense and catch-up bonus accrual.

Excluding these expenses, our gross administrative costs are trending lower. Interest expense before interest income was $30 million for the quarter, which is $5 million higher than our guidance due to lower expected capitalized interest and labor.

On slide 2, we've updated our cash and capital expenditure. At the end of the quarter, we were un-borrowed on the revolver with a $184 million in cash on the balance sheet. With margins improving through the first part of the fourth quarter, along with the execution of lowering inventory levels, our cash balances improved during October.

As noted in the press release, our net debt to net capitalization was 30% at the end of September, which is the lowest ratio the company has reported since fourth quarter of 2006.

Moving to slide 3 is the company's cash flow where you can see that year-to-date; we generated $782 million in cash flow from operations. Under the users chart depicts how we deployed this cash, $500 million for CapEx, $120 million to pay down borrowings on the revolver and $41 million for dividend payments. For the year, we've increased cash $161 million.

Capital Expenditures including turnarounds for the quarter were $137 million and $524 million through the three quarter of 2008. Based on our current plan, we are forecasting to spend less than $775 million for the full year, which is around $100 million below our previous plan.

Moving on to slide 4, let's go through guidance for the fourth quarter. We estimate throughput to be in the Pacific Northwest 140,000 to 160,000 barrels per day; 60,000 to 70,000 barrels per day in the Mid Pacific; Mid Continent of 105,000 to 115,000; and the California region 250,000 to 270,000 barrels per day.

OpEx guidance for the fourth quarter is as follows: $4.05 in the Pacific Northwest, $2.85 in the Mid Pacific, $3.45 in the Mid Continent and $7.15 in the California region. Our depreciation for refining is estimated at $85 million. Additional third quarter guidance items include corporate expense of $45 million, interest expense before interest income of $25 million and a marginal tax rate at 39%.

Everett Lewis is now going to review some of the more significant operational highlights for the quarter.

Everett Lewis - Executive Vice President and Chief Operating Officer

Thanks Otto and good morning everybody. The company has really made significant strides executing initiatives that address the rapidly changing business environment we've experienced. This quarter was a good example of how those efforts result in higher performance. We have been and continue to adjust operational practices for the changing demand and the challenging environment we're in. California gave us an early window into the impact of higher prices than a slow economy could have on transportation fuel consumption. We have reacted by optimizing the system and going to appropriate levels of inventory and production.

We are managing inventory levels and working capital requirements by shortening supply lines on both crude and product. The reduced inventory in addition to better matching working capital requirements or supply, means that crude and product prices, we're going to narrow our window with less risk exposure.

Compared to the second quarter of this year, we significantly reduced our crude and feed stock costs versus our benchmark indicators. In California, we've benefited from a full quarter of operating the delayed coker at Golden Eagle. We also benefited from running better valued foreign cruises in Los Angeles as the old domestic contracts we had expired.

In the Mid Continent regions, we continue to access advantage local crude production and in Hawaii, some simple system changes commit us to largely eliminate the need for expensive lives we cruise [ph]. We also managed our expense structure to suite changing conditions. We have generated and continue to generate reductions across the fixed operating cost categories from both capital and non-capital initiatives. These expense initiatives together with increases in our crude flexibility and yields are designed to improve our performance in a lower margin environment.

As the spread between diesel and gasoline continues to favor diesel production, we have continued to increase our dieseling yield. This quarter, our distillate yield approached 40% versus 34% in the first quarter of this year without significant capital expenditure. Our portfolio of wholesale and retail marketing outlets also contributed to the quarter's performance. The balance system of refining and marketing permits us to capture the available margin even during periods of volatility. Our marketing channels in aggregate contributed over $200 million of operating income in the third quarter.

And with that, Bruce is going to wrap up our cost.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Everett covered several things that I'd like to highlight and I think the first thing is the impact that California and high crude prices had on us earlier this year. If you look back at our third quarter earnings call from last year, we began talking about those impacts on demand. And subsequently, we did outline a self-help program to improve margins.

As Everett talk to us about this program really focused on generating more cash, lowering cost and really transitioning our operational strategy from one that maximized available throughput capacity to one that optimized the profitable data of marginal barrel.

The essence of this strategy shift implies that we knowingly accept the risk that we may sub-optimize our throughput but with low margins that becomes a very acceptable risk. The principle goal that we set up for our self as Otto talked about was to strengthen our balance sheet by paying down revolving debt.

The implication of this shift was that we needed to reduce capital spending in order to fund it with internally generating cash flow. And as he reported by the end of the third quarter this effort has enabled us to repay all our outstanding revolver borrowings. And today our balance sheet is stronger than it was a year ago.

And I have often talked about the commercial nature of the refining business and the fact that globally supply adjustments occurs to balance supply and demand which makes it difficult for margins to be sustained at the year of the golden peak... the golden age peaks or at the ballets that we've seen this year.

Establishing the balance does takes some time and it's been made more difficult this year because of the price volatility that we've seen, we've had hurricanes and then finally it's just been a markets inability to accurately predict for demand. But ultimately the balancing occurs and margins will move to the middle of the price spectrum.

I think that we simplifies with anybody who has to make predictions for next year relative to crude or demand. To say that there's greater uncertainty in the outlook for product demand next year would be stating the obvious.

Our plan and the one we are preparing to review with the board in November is one that expects the depressed market conditions to continue into 2009. That said, I believe that during the years, supply adjustments will provide an expected opportunities to build cash which is what we'll do.

In December, we will talk in more detail about our 2009 expectations at our analysts' day. And before I take questions, I just want to make one more comment. I believe that the third quarter results were the beginning of new and sustainable value for our shareholders. We expect the self-help programs and the capital improvements that we have made this year such as the delayed coker; we expect those to continue to add value next year even if we have the same margin requirement.

In summary, our future plans reflect the following goals to continue to reduce costs, to fully capture the value of products and crude by optimizing our operations and our final plan is to maintain a strong balance sheet by funding capital expenditures with operating cash flow.

And with that Pamela, we are ready to take questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. And your first question comes from the line of Jeff Dietert.

Jeff Dietert - Simmons & Company International

Good morning.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Hi, good morning Jeff.

Jeff Dietert - Simmons & Company International

I appreciate the improvement on cash and inventories. A question on... on 2009 CapEx, can you give us some indication about how you're thinking about that and how you could manage it through what I think you've talked about being a challenging environment next year?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think that just to... I can give you just an overview because we really are still in the throws of reviewing the capital plans that we've got. We started this year, Jeff, with a capital plan that was over $1.1 billion. We've cut it back, we've said we're going to get down to $870 million and we've reported today we think the number is going to probably be about $100 million under that. Some of that just depends... and that's sort of that's timing differences that rolls into next year.

As we look at the plan that we had for originally announced as we talked to everybody last year, that plan was in the neighborhood of $1.1 billion for 2009 also. It won't be $1.1 billion; I can say that with a great deal of confidence. I think that looking at the numbers when we start from a base up, there's... you get your... an EBITDA type of environment with some improved capture rates and other things that may not be in today's models, but we think as people start to take a look at what we're actually generating, our EBITDA is going to be a little bit better than actually people may have forecast for 2009.

You know we are not going to have the derivative impact. So, we're really going through and our goal is to -- it's not only to balance the -- in that margin environment, a balanced capital but it's the balance it in time too; that is to say that we are trying to take into consideration seasonal impacts.

And so, we're going through that right now to look at some of the scope, some of the spending that we had planned to do, some of the turnarounds that we've planned on doing. We... in buying Los Angeles we've got a little bit of a compound turnaround impact for 2009, which we are working on. So, I can't give you the number today because I really don't have it. But it's going to be closer to where our plans works it for this year than it was to the $1.1 billion. And I think by the time obviously we have a chance to review that with the board and by the end of the year we'll be able to share that. But again it's really taking a look at what we think the EBITDA is going to be and how we could spend it.

Jeff Dietert - Simmons & Company International

Good. And I have got quick second question on inventories; you brought inventories down significantly over the last two quarters. Are you close to minimum operating levels, could you talk about inventory management a little bit?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I'll let Everett talk about that but I mean I think that the... you have to tell me exactly where demand's going to be for me to give you a real answer to that. I mean our goal is clearly and operationally, let Edward talk about the fourth quarter. It is to really try to so a better job of balancing total supply and that's the amount of inventory we're keeping plus the amount of production that we generate in particular period.

And I'm not quite sure where that balance is. As I said earlier, I think that the industry's been chasing lower and lower demands and failing to recognize. By the time you purchase crude and look out a month, you will fairly realize how low demand is and we've been slowly creeping up on it. We make the adjustments to both production and to inventory levels. I think we're getting closer. Everett, you want to comment on where we think we're going here at sort of the end of the year?

Everett Lewis - Executive Vice President and Chief Operating Officer

Sure. I mean, we have been and we'll continue to test inventory levels and they will continue to move as the demands move and our markets move. I think our objective in the fourth quarter is to see if we can take them down a little bit further. But I think to Bruce's point, we've made some big changes in the inventory. And while we may move it, additionally in the future, the moves probably won't be as quite as large as they have been in the past. I think in the future, we're going to be more focused on how we can improve our system and do more self help initiatives to raise our performance level.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think just one comment. I mean obviously, when we maybe suggest one of the things that our external auditors looked as whether they are deemed to be permanent adjustments, otherwise, if you have plans to rebuild them, you wouldn't have to see the income impact. And if so and what they are looking at and what we're looking at are really, a period of time, what we're saying demand's going to be lower and we are going to be continually stressing inventory levels to be able to keep them at low levels and that's just smart business. It ends up giving you cash and then this quarter gave us and next quarter may give you some income but it's not really the business driver here.

Jeff Dietert - Simmons & Company International

Thanks for your comments guys.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Okay, Jeff.

Operator

And your next question come from the line of Chi Chow.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Hi, good morning, Chi.

Chi Chow - Tristone Capital

Thank you, good morning. Bruce, on the '08 CapEx, can you give us some details on the types of projects or spending you deferred or cancelled?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I can. We can, all right. Whether I would start to give you a... I think that's an appropriate question and its impact which I think is important as you look at what's going to happen in 2009? So, Everett's got a little charger in front of him... everyone to talk to that.

Everett Lewis - Executive Vice President and Chief Operating Officer

There's a couple of layers we've been through. The first is the basic move we made down to 70. And then there's another... the more recent changes that have been going down from there later this year. And as we have reported before, it's not... we didn't take it all out of income improvement, that wasn't our objective. We've made a more balanced approach at it. So we've taken... we've taken and deferred and changed the scope on the maintenance area, the regulatory area. A little bit on turnarounds, a little bit in income improvement. But really the bulk of it came out of the maintenance and regulatory area. And now it wasn't... what we did though was not short maintenance and regulatory compliance. That would be the wrong conclusion.

What we've done is looked at the scopes in areas where we had incremental expenditures there that might have some lower terms associated with them or areas where we could be smarter about the scope and reduce the cost, could accomplish our safety and compliance objectives. And by putting the team on it, it was a good team, and put all that together, we've been able to, I think, accomplish the objectives of the capital program at a lower number.

Bruce A. Smith - Chairman, President and Chief Executive Officer

I think that... let me... Chi just to put my true sense on this; the budget and the scope of a lot of these projects were developed... obviously we're talking mid year of the year before. The severity in the decline in demand certainly had been appearing.

So to say they were developed in a better period of time I think would be again stating the obvious. We also had a change of management around refining. So we've gone through and that was simply... and when we started making those changes and we went through in one of our first task was to really do zero base look at all those expenditures. And there were things in the scope that had crept in to the AFEs and so as Everett said; we cut out all... just things that weren't necessary. They were... I am not going to say they were gold plating but they were expenditures that would improve but not necessarily, they weren't totally necessary.

So to date what we've done is we have adjusted a lot of that and that's... that frankly is a little bit of what's gong on right now as we look at 2009, it's really trying to turn what we have to do. What is it that's essential without... I mean obviously without giving up some of the income that we would like to be able to continue to show for earnings growth going in 2010.

As I said, the earnings benefit that we're seeing from some of the capital as well as some of the operational tactics relative to capture rate are going to have an incremental benefit in 2009 that we didn't have. We really don't want to get that up for 2010. But at the end of the day, we are... were driven to do one thing which is to go back and balance really capital with the internal generated funds.

Everett Lewis - Executive Vice President and Chief Operating Officer

Let me give you a little more example on that. We had regulatory projects wherein we could spend a little bit more enhancement capital, it would have a modest return for the incremental capital. And a less constrained capital environment that made some sense. What we've done now is we've gone through and examined all that. We've scrubbed out that part of the capital that had those kinds of modest returns because our capital is more constrained. And in that environment, we want to use that kind of return capital for higher return projects and reserve that capital for the income improvement which has better returns.

So, a lot of this is just really optimizing our capital program in view of the constraints we have.

Chi Chow - Tristone Capital

Okay, great, Everett. That's helpful. My second question, can you comment on volume trends or same store sales data for retail sites in your different regions; Q3 and also what you're seeing here in Q4? And if it is possible if you can break it down by California, you tell Washington distribution that would be great.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Well let me do it more grossly rather than by the state at this point. But I can do some of that. I think we have to think of it in context to what's going on in the market place. The day we have is varied in quality about what's happening with overall demand. But I think some of our best data indicates that the California gasoline demand has shrunk by something north of 7%. So you kind of got to start with that as a benchmark. Now we have taken a pretty aggressive look at our stores as we've got into that environment. We're in a position unlike some of the integrators where we really need to make money across our system. We don't have any other support. So we've been pretty aggressive in how we do the balance between price and volume in our stores.

So our volumes are shrunk by more than the 7%, they've shrunk by about 12% year-on-year. But to show you how that works in terms of optimizing, our volumes are down by 12% while margins are double. So, I think you can see where the balance comes between the pricing and the volumes and I think our guys have done a great job optimizing that whole program.

So, the... where the trends are going now, it's really a little too early to tell. But I do believe that the reduced prices are going to kick in some elasticity on demand. And what we've seen in October, based on credit card data and sales data rather than the broader statistics which we think are less accurate is we've actually seen a very slow increase in October over September in terms of the demands and the sales that are going on in California. So, while it's too early to say that as volumes and demands are turning, we are certainly getting some indication that there is some price elasticity in the market.

Chi Chow - Tristone Capital

Hey, great. Thanks a lot. I appreciate it.

Operator

And your next question comes from the line of Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank

Hi everyone, good morning.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Good morning Paul.

Paul Sankey - Deutsche Bank

Could you just take a bit of... more about the revolver. I'm just wondering about the dynamics of that; is it stayed at the same level over the past year and what's the outlook for... I'm thinking about the impact of the people on Wall Street that we've seen. That's kind of one of my questions. Thanks.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Be happy to Paul. Again we put in place the 1.75 original revolver which is a 5-year facility when we acquired the LA refinery. Earlier in the year, because of the volatility, we exercised a portion of the accordion [ph] feature and increased it to $110 million.

As Bruce talked when we put that in place, we had a much different market environment outlook. And so, it was much more capacity than we need for the base operations. We continued to have potential growth opportunities embedded in that. However with the significant volatility, we saw especially during July with crude running up to... close to a $150 million, that additional capacity served us well.

It's primarily as you recall, an LC facility. We occasionally drop on it for balancing our cash flow cycle around our crude settlement dates of the 20th and the 25th. The ability to support that facility comes from AR inventory as well as our cash balances and we've had full availability throughout this year. So availability has not been a problem. As we reported at the end of the third quarter we had 52% capacity availability. So we do not have any concerns whatsoever about that facility being able to support our operations even if this margin environment continues throughout 2009.

Everett Lewis - Executive Vice President and Chief Operating Officer

Of course as crude prices have come down largely the letter of credit has come down also. So just the aggregate issue. So --

Paul Sankey - Deutsche Bank

I'm sorry, also I missed the first number there which is the overall... provide a little over... by now I can look it up but if it's... I know you can --

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

By now it's at $1.86 billion.

Paul Sankey - Deutsche Bank

Thank you. That's --

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

There's only $1.75 billion and then we had a $110 million.

Paul Sankey - Deutsche Bank

And again something that is inserted for the next year. Can you just talk about the schedule that we see over --

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Sure. One other thing in addition, we've also got $500 million of side bilateral facilities for our foreign cargoes. So, in addition to the $1.86 billion, we've also got the $500 million on that side, Paul.

On our debt maturity, the earliest that we have coming up is 6.25% that are due 2012, that's $450 million, the 6 and 5/8 senior notes due 2015, another $450 million; and then the recent 6.5%, $500 million are due 2017; then we have the smaller junior subordinated notes of 150 million that are due also in 2012.

Bruce A. Smith - Chairman, President and Chief Executive Officer

But in '09, '10, '11 obviously, we just don't have maturities.

Paul Sankey - Deutsche Bank

So, basically, the size of your revolver has been stable and increasable if that's the word and the outlook there is I guess... there's nothing... there's no reason to believe it would be available next year and you don't have any major debt maturities until 2012?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

That is exactly correct

Bruce A. Smith - Chairman, President and Chief Executive Officer

That's right.

Paul Sankey - Deutsche Bank

And Bruce what would you... are you just going to try and or also it's about -- are you just going to try and continue to build cash? Do you have an aspiration for how much cash you would feel comfortable with? Is this the right level?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I think... I don't need to be quite that simple but today with the uncertainty that's in the marketplace, I'd be just happy building cash for a while. And I think that... I don't see that if all of a sudden there's and as I said in my comments, I can see how dislocations are going to occur next year and we're going to have a quarter where we do really well. That's not going to change our plans; I think we just build cash until there's some semblance of a reasonable certainty around growing demand and then we'll look at what the options are for using the cash.

I truly don't think it's going to change our capital planning a lot. I don't think as we get to 2010, we don't have the turnaround that we have in 2009. I think we'll find a few other things that we want to do to improve our cost structure that's going to require some capital that may not -- we may not be able to do this year.

But I just don't see us doing something major in the way of using cash to buy facilities or taking on a big project. I just see us accumulating cash and I don't know how much I would want to talk to the board about where we feel like that. It looks like something we want to do, something elsewhere.

Paul Sankey - Deutsche Bank

Great. That's great. Thanks a lot. And then just on the industry kind of environment. Could you just talk about trade in California? How much imports, you are exports, any other interesting elements there? And that will be the end for me. Thanks.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Okay, thanks. I think we've seen the obvious. I mean, as demands have come down as they have in California, we've seen imports reduced. There are still some small amounts of statistic gasoline imports on particular situations. But, generally gasoline imports are the thing that go past and for the most part. I think the distillate market is more interesting, like the California distillate market is really being driven in price of the world market. So, we and others are really are exporting our marginal diesel to markets outside California, and that's really more of the pricing mechanism in California is.

So those are... the other thing as we and others have done things around fuel oil, as we've seen fuel oil markets weaken in the past, and I think the activities that have gone worldwide reducing topping arms, plus power actions and others on the West Coast, that have changed the balance of fuel oils that you've seen a pretty dramatic change in the secondary products that has made a real difference to some of our economics.

Paul Sankey - Deutsche Bank

Do you have a sense to how much distillates being imported, it's not oil captured by market data?

Bruce A. Smith - Chairman, President and Chief Executive Officer

That is being exported.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

That the game is being imported.

Paul Sankey - Deutsche Bank

No, that's what I meant really from a speck. Do you have a sense of how much is it being exported?

Bruce A. Smith - Chairman, President and Chief Executive Officer

We can't... I can't speak what everybody else does, we've done probably half a dozen cargos.

Paul Sankey - Deutsche Bank

In the quarter?

Bruce A. Smith - Chairman, President and Chief Executive Officer

No, not the quarter.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

No, not the quarter.

Bruce A. Smith - Chairman, President and Chief Executive Officer

But at least there's been a robust market; and I think that anybody that's got the luxuries obviously is going outside the country. So I don't --

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

But, I agree, yes. I don't think we can give you a specific number about what the industry has done to export out for west Coast.

Everett Lewis - Executive Vice President and Chief Operating Officer

So these exports have gone from 20,000 barrels a day last year, in the month they to 87,000 barrels a day.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Producing about 600,000 barrels a day and internal demand in fact is 530 and 550, somewhere in that 50,000 barrels range. So we believe that will suffice.

Paul Sankey - Deutsche Bank

Right. So, percentage of margin is leaving to the... and that's what period of time.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

That's in the second quarter.

Bruce A. Smith - Chairman, President and Chief Executive Officer

In the second, yes.

Paul Sankey - Deutsche Bank

Okay, that's helpful. Thank you, guys.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Okay.

Operator

And your next question comes from the line of Ann Kohler with Caris & Company.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Hi, Ann.

Ann Kohler - Caris & Company

Good morning. Could you maybe just give us a little bit of color regarding the turnaround activity that you see for 2009?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I can't do that yet, we're still working on that also. I means that's... that is a big part of our moving target with capital.

Ann Kohler - Caris & Company

Okay. And then, I know this is totally the first year. We did see sort of a return of the historic seasonality in sort of margins profitability and throughput, is that something that we should expect for the next couple of years?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I don't really know what caused -- I think we will find somebody there to answer that.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think the seasonality or what you perceive as seasonality has really been more economic activity than anything else and I think that's overwritten, any seasonality concerns that we might see. So once we reach a stable level of economic activity, I mean it will always see...

Bruce A. Smith - Chairman, President and Chief Executive Officer

It's hard to separate it.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

It's hard to separate it because that tends to have more seasonality on gasoline.

Ann Kohler - Caris & Company

Right, and I know... I mean in the last couple of years that's been a little more muted. But, I mean if you go back a few years, and sort of the fourth and first quarter, you'd typically scale back runs given just as, just from...as you've said from the gasoline and seasonality perspective. So I would anticipate that you start to see that continuing.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Well as Everett said in the past couple of years the marginal supply has been imports. So that what really switched seasonality and we maximized runs all the time. With imports not being a factor anymore, now it's more production... local production that has to do the seasonal balance. So I think it'll show up more or now simply because that's the marginal barrel whereas the past marginal barrel was the import.

Ann Kohler - Caris & Company

Right, okay. Thank you.

Operator

And your next question comes from the line of Roger Read with Natixis Bleichroeder.

Roger Read - Natixis Bleichroeder

Hi, good morning gentlemen.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Good morning Roger.

Roger Read - Natixis Bleichroeder

I was hoping we could do maybe a little bit of postmortem on the Q3 performances is idea. Maybe what to look for in the fourth quarter recognizing that crude prices have been volatile mostly in one direction. But of the hedging gain and to a lesser extent, the optimization, the $148 million and $142 million, can you kind of walk us through what the hedges were? How that might affect Q4? And then what you can do optimization wise excluding what happens with the crude price and sort of that impact on inventories as you look at the fourth quarter in terms of trying to optimize your throughputs, etcetera.

Bruce A. Smith - Chairman, President and Chief Executive Officer

That's a broader question.

Roger Read - Natixis Bleichroeder

Well all the specific questions, they're already been taken. So, I thought I do a broader one.

Bruce A. Smith - Chairman, President and Chief Executive Officer

You really went deep. Well, I talk a little bit to the hedging. As we explained last time, we were kind of changing how we went about that. And one of the things that's come out of that as we shortened our supply lines, our pricing exposure has gone down. So, the amount of crude and product we have exposed and we shortened the supply lines and shortened the inventories has come down considerably. And a lot of that volatility is offset by things that happened on the marketing side and things that happen on some of our product pricing. So, we haven't found a need to really do a lot of hedging around our price exposure. We don't see that it's that high.

Roger Read - Natixis Bleichroeder

So as I think about the fourth quarter is that hedging component not there on a sequential basis or the hedging strategy can still work in a declining price environment?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Yes. I mean I think what we're doing is what we'll continue to do. We'll continue to access our management program but I think where we are right now is appropriate to the market condition at where we are.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think the one other things Roger that we talked about a long time ago with analysts and we've given up the last half of that but was a project to put in technical tools and software to really help us better understand our crude inventories and how to manage risk around that and that is something we completed.

We've decided that we can't afford to put in the product side of that right now but it's starting to pay real, we're trying to see the benefit of that of seeing where we've actually got price exposure. And we've been able to significantly reduce the barrels at risk and understand what's at risk. And so, I don't think any of this is going to change. I think we're on a path now with the fact that this is come online to continue to do this regardless of what happens now with price.

Roger Read - Natixis Bleichroeder

Okay. And then in terms of optimizing your throughputs for the fourth quarter and looking at the kind of optimization performance there in third quarter and I recognize you're talking about different products and moving and where crude goes and so forth. But what do you feel, should we be at a situation where given your internal efforts you're more let's say close management of inventories and throughputs.

We should see a sequential improvement in optimization in any quarter excluding sort of major turnarounds going on?

Everett Lewis - Executive Vice President and Chief Operating Officer

I think you should expect sort of the same levels you've been saying. If you look at in terms of capture rates, I think you can see our capture rates have improved relative to our index and our intent would be to continue to probably at least at that level of improvement. The team has been focused a lot on the inventory, getting our production levels to the right place and matching up with the markets.

And I think going forward, we need to get into a more sustainable mode and we're going to be even more focused on the optimization and the improvement initiative activities. And I've got a list of 130 ideas which the group came up with just over the last few weeks of additional things we can do and look at going forward to advance that effort. So I would see the level of success there to continue at or above the levels you've been seeing so far.

Roger Read - Natixis Bleichroeder

All right. Well I know it was a broad question and I didn't expect to get this very specifics but that's helpful guys. Thanks.

Bruce A. Smith - Chairman, President and Chief Executive Officer

You're welcome Roger. Good question.

Operator

And your next question comes from the line of Paul Cheng with Barclays Capital.

Paul Cheng - Barclays Capital

Hi guys.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Hi Paul.

Paul Cheng - Barclays Capital

How are you doing?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Congratulations.

Paul Cheng - Barclays Capital

Thank you. Could be fireworks. A number of quick questions. On the balance sheet, Otto, can you give me what is the working capital, the long-term debt? I presume all the debt is long-term, and what is the market value of your inventory in excess of the both?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Sure. Current assets less cash, $2.81 billion. Current liabilities less current maturities, $2.88 billion. So, net working capital are negative 70. The long-term debt and capital lease is 1.54 billion. Book value of the inventory 850 million and total market value of $1.9 billion. So about, little over $1.05 billion of excess on the inventory.

Paul Cheng - Barclays Capital

Otto, when you're saying that the working... the current asset excluding cash and do you have any debt that you see in the current portion?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

No, that excludes the current portion of the debt.

Paul Cheng - Barclays Capital

Yes, I know.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

That's in the long --

Paul Cheng - Barclays Capital

What's the debt on the current portion? Well it should be --

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

We got the periodic amortization. So it's very small. That means zero.

Paul Cheng - Barclays Capital

Okay. So that in all practical method that I should assume including cash, your working capital in the more traditional sense is above 110 million positive.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

That is correct.

Paul Cheng - Barclays Capital

Okay, very good. And I think Bruce, if we go back into the earlier question on the hedges, do we still have any hedges that in the forth... current forth quarter? In other words, that with the oil price comes down, if you have any hedges, I presume that you make money; do we have any hedges positioned on?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Certainly we make a million hedges. We're... what we are doing is the same thing we've been doing. Where we end up in a situation where we have any inventory or any volume above our target levels, then we look at putting in hedges in place. We also look at some specific situations. I mean an example in the third quarter is we bought some longer hall crude, a medium hall crude that was particularly flavored to diesel and there was a price premium associated with that. So we lock in some of that diesel exposure on that particular cargo. So, we have... once in a while we do an opportunistic hedge on something like that and we'll do it if our inventory levels are above our targets for some reason for a period of time. Other than that we do very little.

Paul Cheng - Barclays Capital

Sure I fully understand why you may enter the hedge. I guess my question is that as of now, do you have any hedges on?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Yes, but they are very few.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Paul, just to give you perspective that once the queue comes out probably later this week or early next week as we talk, we've significantly reduce the types and amounts of hedges we've got and just in comparison we'll have five million barrels of open net positions reported at the end of the third quarter compared to about 13 million barrels at the end of the third quarter last year.

Paul Cheng - Barclays Capital

How about at the end of the second quarter? Do you have [multiple speakers].

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I didn't bring my queue Paul. So, we can get back to you with that figure.

Paul Cheng - Barclays Capital

That would be great. And Bruce in 2009 of course that we don't know what is the capital spending that we get. But can you tell us that what is the minimum that you have to spend for 2009?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I really can't even do that. I mean I don't have that with me. I can't tell you.

Paul Cheng - Barclays Capital

Okay. And we talk about the diesel market export. For you guys, where is the primary exported destination. Is it to South America or --

Bruce A. Smith - Chairman, President and Chief Executive Officer

It actually moves around. It depends on where the market is in a particular season and at a particular time. Earlier this year, it was South America, a lot of those going to Chile. More recently we're looking at taking it to Mexico where they have their own product demand growth and shortages. So I expect it to move around as the markets continue to readjust to the kind of dynamic situation we have.

Paul Cheng - Barclays Capital

I see. Okay, very good. Thank you.

Bruce A. Smith - Chairman, President and Chief Executive Officer

You are welcome.

Operator

And your next question comes from the line of Arjun Murti with Goldman Sachs.

Arjun Murti - Goldman Sachs

Thank you. Bruce, maybe just a follow up to the last question. In your analyst presentation from last year of the $1.1 billion budgeted, it looks like about $600 million to $700 million was for regulatory turnaround to maintenance. I guess I presumed there's probably not much flexibility to that or can some of that be differed into the following year to kind of get to that minimum CapEx in case the environment stays worst than expected next year?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I think that again, some of that like is ever talked; we had some regulatory capital that we started with that would have been AFE, that would have been [indiscernible] in the next year that would... it's already been adjusted and scoped. So the number's certainly not going up from there. I would think that we've been able to look at both of this as ever talked. Both the maintenance and regulatory and those programs that might have been ongoing through the multiple years here where we'd suspended to change of scope would reduce that number.

And so, I think you're going to see all the levels of spending that we're in that analyst state presentation going down. I know, I certainly don't think they're going to be going up even on the regulatory maintenance side.

Arjun Murti - Goldman Sachs

Thank you. That's helpful. The related part of that would be, it's probably too early because the downturn is sort of just accelerated in this last quarter, but either easing engineering construction costs or steel costs. Clearly, steel is down, but you are going to sense that any of the other engineering or construction costs are coming in or that some of the bottle next year being eased off the potentially lower these capital requirements.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Clearly, the steel's has down.

Everett Lewis - Executive Vice President and Chief Operating Officer

Towards processing and sharing.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Dan Porter is the Senior Vice President of Refining; you want to go ahead?

Dan Porter - Senior Vice President, Refining

Yes, I think we're seeing exactly what you were indicating that in all aspects of project execution that the industry is slowing down in terms of the work that's being executed. And therefore contractors are more interested in work and so we would expect that in all aspects if the potential is there for a decline and the cost of executing projects going forward.

Bruce A. Smith - Chairman, President and Chief Executive Officer

And I think you're touching on something that's even more significant, Arjun, meaning if you look at... we're focused on next year, but clearly with the macro changes that have occurred for producing countries with crude prices being down, with the margins being down on this. Even with capital costs coming down, we certainly believe that a lot of this supply that was originally scheduled is going to be at risk.

And that probably will delay for some years, at least the increase of that. And, so, when demand returns and we believe demand will return, that's a question of timing, and I ... you're better... maybe better qualified to predict that than I am. But, I think we're going to see another return, where things are going to be better than expected. Not... I don't think again the high years that we've seen, but I think we're going to see a period of time where things are going to be a little stronger.

And there's been a big shift that a lot of old data is out there, and as we've looked at those capital costs, our question's been, does that change really the supply picture, and our feeling is it didn't going to change the supply pictures. There are so many demands for producing countries to be able to balance their budgets right now. I don't think new refineries are going to make the cut.

Arjun Murti - Goldman Sachs

That's really helpful. Thank you very much.

Operator

And our next question comes from the line of Neil McMahon with Sanford Bernstein.

Neil McMahon - Sanford Bernstein

Hi. Just a few questions. First of all, on your retail and commercial marketing margin that you got in your press release, are you campaigning those margins, I just made on the retail business at the stores. Or also, are those margins including all of that from the say the wholesale refining business such as coke and lube sale?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

We're including the wholesale margin. We're talking about the total numbers of improvement on EBITDA. It's not just the retail.

Neil McMahon - Sanford Bernstein

And, what have you been seeing in some of those older products from the wholesale, has it been the bits and pieces outside gasoline and diesel that have had really strong margins as well.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

We are seeing some improvement on heavy oil side too and on the secondary products. Those have been at least as important as anything on the light product side.

Neil McMahon - Sanford Bernstein

Okay. And like you mentioned you had just the crude cost mainly along valley refinery, was the change in the contract structure there? Have you got any initiatives for this quarter in terms of seeing any further improvements? Are we to sort of assume those are the major step changes that have gone in so far?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think we are continuing to look at other things. We've got some cargos of the Brazilian heavy coming around. We found some ways to get around some of our McCaston [ph] trading limits on the light end. So we're able to run some of the different flavors of crude. And I think we are seeing as demand goes down, we're getting a lot more options on different kinds of crude from different locations with more aggressive pricing available to us. So we're continuing to see examples.

Neil McMahon - Sanford Bernstein

And actually improves credit terms.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Yes. So I... there's... we haven't run that string out at all yet and we are seeing at it more than just the LA location mentioning the Golden Eagle as well.

Neil McMahon - Sanford Bernstein

And what about the availability and using residual fuel. Could that be any potential advantage this quarter over last quarter?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

It could be and we're experimenting with a lot of that. We've got heavy crudes are getting more expensive and to some extent they're almost getting busy in the other direction as some of the cokers come on line. So we've actually run a test run taking some of our SDA pitch down from... and the quarters to put it in the... one of the cokers in California.

We've got... people don't often know this but the SDA coker is actually build as a resid SDC and during part of the time this year we've been running in that mode, converting some of the resid from the crude in our quarters through SDC and SDA combination.

So we're looking at a lot of different ways to further optimize the resid, use of our plant and as the total. We were in a mode where we were running flat out because the light cracker was so good and to effectively do that, we ran a little lighter crudes through our plants to multiply the capacity. We are coming down on capacity. We've got completely other options to work it out around the cokers and the conversion capability that they will find up other opportunities.

Neil McMahon - Sanford Bernstein

Great. Just one final one from me. Just looking for an update on Hawaii and both from a point of view of further refineries running or what you're doing there. Plus also looking at the L.A. refinery in terms of how that's performing versus your expectations since you acquired it? Thanks.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Couple of things. We are... in fact our entire system, we're looking at production levels that are really appropriate, suited to the markets where we are and where we have our particular advantages, we're doing at Hawaii as well. So, we are really balancing production there with the market. We've also done some real simple things to improve the capability of that refinery.

As I mentioned earlier, we have done some simple things on the crude unit so we don't... we are not force to run the light sweet crude there anymore. So, we're in more of a mix of light sour and heavy sweet for the fuel oil production that is pretty attractive.

As the distillate prices have got more attractive, Hawaii is really a distillate machine and a distillate market. So that's really been to the advantage of the Hawaii situation. As what we're seeing now, as the topping room come off in Asia. A lot of those crudes are coming down in price, some of the sweet and light premiums are coming off. So, we've got a lot more choices on how we optimize that story that we did say, a year ago.

Around LA, the choices, and also some new crude that are ... That's true across our system.

Around LA, our operating expense there is well in excess of our expectations. The group there has done some really creative things. And they've done; I think the coker rate there is, what is it running down?

Everett Lewis - Executive Vice President and Chief Operating Officer

24,000 barrels a day. And we've extended the time between decoke to a level that's far beyond what was happening before. So both, and just daily capacity and time between de-cokes we've made some dramatic differences in the coking capacity we had there over what we expected. So, I think the team there is just... they are doing a great job. They've been really responsive to changing of diesel yields around as well as getting the utilization to plant beyond wherever... it ever was. So, we are very pleased with that operation.

Bruce A. Smith - Chairman, President and Chief Executive Officer

The work force is there, I mean, I want to just add is very engaged in trying to generate new ways to improve the plan, both with low levels of capital with no capital and they've been working. It's... we have a very interactive process that's been going on for about two months.

Everett Lewis - Executive Vice President and Chief Operating Officer

About two months.

Bruce A. Smith - Chairman, President and Chief Executive Officer

About two months now, which is showing signs. So, I think as what Everett said, we knew we had more maintenance there that those numbers, when we look at all the maintenance numbers that we show, we've got a disproportionate amount that we're spending there much like we've spent at Golden Eagle for a few years. But people are really engaged in finding ways to make improvements to generate more income there and to reduce cost. So... and we've been through some little hard time with market maybe to be able to see it, but as we've gone out of these old crude contracts and we start to see some of those other benefits and start to see cost drop, I think people are going to be surprise by what it does.

Everett Lewis - Executive Vice President and Chief Operating Officer

I think that's true. I mean... it is not a top performer energy and it's not a top performer on maintenance. In fact it quite the other way around. And that's sort of a good thing and a bad thing. It's really a target rich environment. We've got crosses going there right now and it's really interactive with the employees themselves looking at the maintenance productivity which is quite low and take that up and just that alone would make a significant difference from the maintenance costs and there's a lot of initiatives under way looking at how we can optimize the energy consumption there and there's a lot of room of improvement, lot of low hanging improvement.

So running into 2009, that's going to be a big part of how we continue to sustain our performance in the slower margin environment.

Neil McMahon - Sanford Bernstein

Great. Thank you.

Operator

And your last question is a follow up from Jeff Dietert with Simmons.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Hi Jeff.

Jeff Dietert - Simmons & Company International

Hi, my question was answered. Thank you.

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

Okay.

Operator

And do you have any closing remarks?

Otto C. Schwethelm - Senior Vice President, Chief Financial Officer and Treasurer

I think the only thing I would say is that obviously it's been a very good quarter for us. We are very pleased with the progress that the corporation has made and really focusing on a changed in environment. I think all of our employees are really engage in that process.

I think there's more to come. We're very optimistic about what we can do. The challenges, obviously the mark employees that we think will extract more out of the market place today than we would have at the beginning of the year. So we're encouraged. We look forward to being able to get together with everyone and the force in December. And to be able to talk more specifically about our plans and what our attempts are going to be to be able to generate more income in 2009.

So we look forward to seeing you at that time and then also for those of you who can make that at the earnings call at the end of the fourth quarter. And again if there are any follow-up questions or things that you would like to talk to us about, Scott's available and be more than happy to answer questions.

Again, thank you for participating today.

Operator

This concludes today's conference call, you may now disconnect. .

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